A study entitled “Impacts of Delaying IDC Deductibility” was published recently by Wood Mackenzie Consulting and was commissioned by the American Petroleum Institute (API) to estimate the effects of an Obama proposal to eliminate federal tax deduction of intangible drilling costs used by the oil and gas industry and to instead require that these costs be treated as a capital expense. You can read the entire study here.
The difference between a deduction and a capital expense is huge. A deduction allows you to use the entire amount of the deduction in the year it was incurred. If these costs are treated as capital expenses, only a small portion of the total can be deducted each year over the useful life of the relevant asset. Intangible drilling costs are currently deductible like other operating costs and the deduction allows oil companies to use that saved money immediately for other projects. Intangible drilling costs include costs like wages, fuel and repairs, and accounts for 60% to 90% of costs for a given oil or gas well. Most industries deduct expenses like these in the year they were incurred. The Obama administration, however, wants to single out the energy industry for special treatment (again).
The study looks at the impact if this proposal was effective January 1, 2014. The study estimates that in the first year alone, elimination of the intangible drilling cost deduction would result in the loss of 190,000 US jobs. By 2019, the study estimates 233,000 job losses. Energy investment would be expected to drop by almost $40 billion per year between next year and 2023, for a total investment loss of $407 billion. U.S. oil production would drop by 520,000 barrels per day in the first year and 3.81 million barrels per day by 2023. There would also be 8,100 fewer wells drilled by 2019 and 9,800 fewer by 2023, contributing significantly to the drop in productivity. The study finds that some smaller companies may not be able to invest in drilling and development at all if the change were to take place.
There was a teleconference on this new report on July 11, 2013 and Stephen Comstock, API’s tax and accounting policy director, said, “Repealing the IDC deduction would actually lead to long-term declines in federal revenues, state taxes, and royalty payments to private landowners. If policymakers want to generate more revenue from oil and natural gas production, raising taxes is the wrong approach.”
The study indicates that if the current system of deductions remains in place, U.S. oil and gas production is expected to increase at a steady rate over the same years- adding as many as one million jobs- and that stability in the federal tax code would promote further investment in the industry. Keep in mind that foreign investors in domestic energy projects give great weight to the stability of the tax code in general, and on these deductions in particular, when deciding where to make investments.
As a Texas oil and gas lawyer, the outcome predicted by this latest study seem obvious. Promoting energy investment, energy sufficiency and job growth seem to be outcomes to be desired. Given the unemployment and budget problems the country is facing, this study should provide food for thought on what is the best way forward to promote a healthy energy sector and economy as a whole. I agree with Mr. Comstock when he concluded that “We urge Congress and the President to always approach the tax code with an eye toward fairness, job creation, and American energy security.”
Of course, Obama has long been interested in beating up on the energy industry. The frightening thing is that he often seems unaware of the unintended consequences of proposals like the elimination of the IDC deduction. It’s ironic that he has repeatedly said he is seeking ways to minimize the deficit and increase job growth, yet he supports this proposal that would have the opposite effect, and while refusing to allow leasing of federal lands. Go figure.
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